Federal Medicaid law makes Medicaid the payer of last resort. Under 42 U.S.C. § 1396a(a)(25), states must take all reasonable measures to identify third parties legally responsible for a beneficiary's costs, including commercial and employer group health plans and pharmacy benefit managers, and bill those parties before Medicaid pays. When a provider bills Medicaid without first exhausting a known third-party payer, the state can treat the payment as an overpayment and recoup it in full, sometimes years later. For a compliance officer, third party liability, or TPL, is an audit exposure that state Medicaid agencies pursue directly against providers, not a back-office task.
The Payer of Last Resort Rule Under Federal Law
Section 1396a(a)(25) requires every state Medicaid plan to ascertain the legal liability of third parties for care furnished to beneficiaries and to seek reimbursement to that extent. States meet this obligation in one of two ways. Under cost avoidance, the state rejects a claim up front and directs the provider to bill the liable third party first. Under pay and chase, Medicaid pays the claim and recovers from the third party afterward. The Deficit Reduction Act of 2005 broadened the definition of third party to include self-insured plans, ERISA group health plans, managed care organizations, and pharmacy benefit managers, closing gaps that let some payers avoid coordination-of-benefits obligations.
Cost Avoidance, Pay and Chase, and the Narrow Exceptions
Federal regulations at 42 C.F.R. § 433.139 set the operating rules for both methods. A claim submitted without documentation that a known third party was billed first, or denied the claim, is rejected under cost avoidance or later recouped. One exception applies: for preventive pediatric and EPSDT services, and for prenatal claims tied to child support enforcement, Medicaid must pay first and pursue the third party afterward, so care is not delayed by a coordination-of-benefits dispute. States may hold those claims up to 90 days if cost-effective. Under pay and chase, the state must attempt recovery within 60 days after the month it paid the claim, unless recovery is already deemed not cost-effective.
Where Provider Recoupment Exposure Begins
Most state TPL recoupment actions trace back to the same fact pattern: the beneficiary's file showed other insurance on the date of service, and the provider billed Medicaid as primary without documenting a denial from that carrier. When a state's TPL vendor, or a managed care organization administering the benefit, finds the gap through an audit, often opened with a self-audit demand letter, it issues a recoupment for the full payment, not just the gap owed by the third party. A provider who identifies the error and does not return the overpayment risks exposure under the False Claims Act, since knowingly retaining an identified overpayment can create liability of its own. Providers who dispute a TPL-based recoupment retain the right to pursue an audit appeal rather than treat the notice as final.
Extended Third Party Liability Obligations on Insurers
Section 1902(a)(25)(I) of the Social Security Act, as amended by the Consolidated Appropriations Act, 2022, also constrains the third parties themselves. A liable insurer, self-insured plan, or pharmacy benefit manager cannot deny a claim solely for lacking its own prior authorization if the state already authorized it, must honor the state's assignment of the beneficiary's rights, and must respond to a state inquiry on a claim submitted within three years of service within 60 days. This matters to providers directly: a recoupment resting on a third party's denial may itself rest on an improper denial, which can be the basis for reversal on appeal. Sustained, uncorrected TPL failures can also draw HHS-OIG program-integrity attention beyond a single recoupment, up to a payment suspension pending investigation or, in the most serious patterns, OIG exclusion.
The third-party denial behind a Medicaid TPL recoupment must itself comply with federal extended TPL rules, and a provider who accepts a flawed denial as final gives up an appeal argument it may not know it has.
Why Early Legal Counsel Is Critical
It is critical that providers promptly retain healthcare defense counsel upon receiving a TPL recoupment notice or any other Medicaid program-integrity inquiry. Early legal intervention can protect the provider's rights, ensure the response reflects what the third party actually required, avoid inadvertent admissions in a self-audit submission, and allow counsel to communicate with the state agency and its recovery vendor on the provider's behalf. Delaying representation can significantly affect the outcome of a TPL audit.
How Health Law Alliance Can Help
Health Law Alliance represents pharmacies, physician practices, and healthcare companies against Medicaid TPL recoupment demands and the audits that follow them. The firm's Medicaid audit defense practice evaluates whether the state's underlying third-party denial was proper and whether a recoupment can be reduced or reversed on appeal. If your practice has received a TPL-based recoupment notice, contact us today for a free consultation.
